Health Reform for Beginners: The Employer Tax Exclusion
This is why people are bored by health care policy. This, right here. The fact that the central concept in health care reform relies on the differential tax treatment of health care benefits when provided by your employer. Even italicizing that sentence doesn't make it more interesting.
But the importance of the employer tax exclusion is simple enough: The hinge question in health care reform is "where do you get the money?" And the main -- and most controversial -- pot of money in health care reform comes from the employer tax exclusion.
That is, somehow, fitting. It is perhaps evidence of the chaotic, unplanned, irrational nature of our health care system that the most decisive piece of health care policy -- save maybe Medicare -- is a World War II-era tax quirk. The Roosevelt administration had instituted wage and price controls to prevent profiteering. Excess profits were taxed at mind-bogglingly high rates. Wages were frozen so employers couldn't offer raises. But the government decided to exempt health benefits from these rules. So corporations took their wartime profits and plowed them into health care benefits. In 1953, with the war over, the IRS tried to overturn the rule. Congress overruled the IRS.
And so here we are. If you walk out, on your own, and attempt to give your friendly neighborhood health insurer a dollar, you're taxed on that dollar. If your employer gives the health insurer that dollar on your behalf, that dollar is not taxed. As a result, getting health insurance through your employer became -- and remains -- a much better deal than purchasing it with your wages.
This created, as you might imagine, a massive employer-based health insurance market. In fact, it made employer-based insurance the default, as you can see in the graph on the right. This has been bad for three main reasons.
The first is that it's regressive. This is intuitive enough: The people who enjoy the tax break are employed. The people who enjoy the biggest tax break have employers buying them extremely comprehensive health benefits. Both types of people tend to be richer than people who are unemployed.
The second reason is that routing health care through employers twists the system in all sorts of horrible ways. Individuals don't know how much their employer is paying for health care. They don't know how much they're not getting in wage increases. They don't know how much premiums are growing every year. (Out-of-pocket costs are a small fraction of total health care spending, as you can see in the following graph.) Protecting individuals from seeing the full cost of health care reduces the political pressure to reform the system. It leaves them more dependent on their employer and less able to start a new business or take a job with a small company.
The third reason is that the subsidy -- and that's what this is, a subsidy to employers who offer health care -- is very big, and quite hidden. In March 2007, the Joint Committee on Taxation estimated that ending all employer-related tax breaks for health care would raise $1.23 trillion between 2009 and 2012. That's more than $300 billion a year. That's much more than you'd need to pay for health care.
But it's a hard more to get your hands on. Doing so raises taxes on 60 percent of Americans. When John McCain proposed replacing it with a tax credit during the campaign, Barack Obama savaged him. Effectively. Now that Obama is president, however, he needs to capture some of this money for health reform. And so the current thinking is that you don't repeal the tax breaks. You just cap them. Maybe you cap it by income, so richer people pay more taxes. Or you cap it by the value of the health insurance plan, so premiums in excess of, say, $12,000 are taxed on whatever falls beyond the line. You argue over their regressivity rather than their very existence.
This concerns some unions, who have bargained for better-than-average benefits and don't want to see them taxed. It'll worry a lot of workers. It'll give opponents of health care reform the same attack line Obama used so effectively during the campaign. It'll give Obama's political people heartburn. But if you want to pass health care reform, it probably has to be done.
Further Reading: "Tax My Health Benefits. Please." by Jon Cohn.
"The Tax Exclusion for Employer-Provided Health Insurance: Policy Issues Regarding the Repeal Debate" by the Congressional Research Service.
"The Tax Treatment of Health Insurance: Early History and Evidence, 1940-1970" by Robert Helms.
"Limiting the Tax Exclusion for Employer-Sponsored Insurance Can Help Pay for Health Reform" by the Center for Budget and Policy Priorities.
(Graph credit: Kaiser Family Foundation.)
May 21, 2009; 5:00 PM ET
Categories: Health Economics , Health Reform For Beginners
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